Dynamic Estimation And Forecasting The Term Structure Of Chinese Treasury Yield Curve

Yield curve at any time is depicted to describe the relationship interest rate andmaturity. In terms of theoretical relationship, interest rate term structure is the functionform of yield curve. The yields of national treasury are regarded as risk-free interest rate,which is used as benchmark when investor compares other financial asset return ordesigns financial tools. Meanwhile, the return to maturity in the treasury market alsoaffects other aspects beyond financial market. For example, short-term interest rate hasalready been the most important instrument in the toolbox of officers in the central bank. Itis not also a message sent through opening market operation, but also a useful tool forcentral bank to adjust inflation and macro economy.Under such circumstance, this paper centers on the dynamic estimation and forecastof interest rate term structure. We summarize popular dynamic method in the existingpapers, and introduce the dynamic factor model as the framework for subsequent analysis.In this framework, we interpret the short-term, medium–term, and long-term parametersas slope factor, curvature factor and level factor respectively, three of which drives theco-movement of yield curve. It proves the good of fitness is improved significantly. In theestimation, we employ a method to largely simplify the factor estimation procedure.Specifically, we set one of four parameters as value we choose. Our main conclusionincludes:1). Dynamic Svensson Model overall dominates the performance of Diebold-Limodel in the sample estimation, while Diebold-Li model shows a good performance in theout-of-sample forecast, especially in the6-months ahead forecast. Besides, dynamicprocesses applying to factors exert a positive influence on the yield curve forecast.